Acquiring a Danish company Financing The Acquisition Using the Target s Funds

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1 International In-house Counsel Journal Vol. 4, No. 13, Autumn 2010, 1 Acquiring a Danish company Financing The Acquisition Using the Target s Funds DAVID SANDER HJORTSØ Senior Legal Adviser, Danske Bank A/S, Denmark Acquiring a Danish company 1 poses much the same challenges as acquiring a company in most other jurisdictions. However under Danish law issues may arise relating to the financing of the acquisition and the post-acquisition cash flow of the acquired Danish companies. The issues arise as a result of limitations that are only to some extent found in other jurisdictions 2, and thus are often the obstacle that acquirors not familiar with Danish law will face. This article will provide an overview of the limitations relating to the financing of an acquisition of a Danish company and the most common ways an acquiror can structure the acquisition around these limitations. 1 Briefly Danish M&A Mergers and acquisitions in Denmark are similar to the M&A process in other jurisdictions. The process will thus be divided in to similar phases as and modeled around the Anglo-Saxon M&A process. Denmark will generally accept and uphold the choice of foreign law in any agreements, however subject to any prescriptive provisions under Danish law and a general ordre public-principle. While one should always seek local counsel to make sure that no hidden risks are taken, a few quick observations are worth making: A Danish NDA is similar to an Anglo-Saxon NDA, however only in certain circumstances are non-solicitation clauses enforceable 3 irrespective of the governing law chosen in the NDA. The Due Diligence review will often focus on environmental claims as these are subject to lapse only after 30 years, whereas normal claims will lapse after 3 years. 4 1 This article deals only with the acquisition of Danish public limited companies (Dk: Aktieselskaber) and private limited companies (Dk: Anpartsselskaber). These are by far the most common types of Danish companies, however under Danish law a company may be incorporated in any manner and form, thus any number of different types of companies are possible. 2 Similar restrictions on financing the acquisition of own shares (typically called self-financing) exist in Sweden, Norway and Finland. In Norway the prohibition stems from the Norwegian Public Companies Act (No: allmennaksjeloven, sections 8-10 and 8-11). In Sweden the prohibition stems from the Swedish Public Companies Act (Sw: aktiebolagslagen, chapter 21, paragraph 5). In Finland the prohibition stems from the Finnish Companies Act (Chapter 13, Section 10). England has a similar prohibition on self-financing for public companies, however this prohibition can be overcome by reregistering the public company as private company immediately after the acquisition. 3 Danish Act on Job Clauses, Act no. 460 of 17 June Danish Limitation Act, Act. no. 522 of 6 June 2007 International In-house Counsel Journal ISSN print/issn online

2 2 David Sander Hjortsø When acquiring a company the acquiror will step in to any rights that the employees have vis-à-vis the acquired company, including any union memberships and special union agreements. These may be rescinded during a short time period subsequent to the completion of the acquisition. 5 The acquisition and the announcement hereof may be regulated extensively to the extent there are minority shareholder interests in the acquired company. 2 Background 2.1 Self-financing what is the problem? Financing an acquisition is often one of the more complicated parts of an acquisition, both from a commercial and from a legal perspective. Avoiding or minimizing this part of the process often allows for much faster and cheaper M&A processes. Acquirors of Danish companies will typically want to recover as much liquidity as possible from the acquired company (hereafter called the Target) in connection with the acquisition or as soon as possible after having completed the acquisition of the Target. Unfortunately it is also at that time that many acquirors run afoul of the prohibition under Danish law for a company to directly or indirectly provide a loan or grant a security over its assets, when that loan or security is used to finance the acquisition of the shares of that company (self-financing). These issues arise under the existing Danish Public Companies Act (hereafter DPCA) and Danish Private Limited Companies Act (hereafter DPLCA) 6, both of which are in the process of being replaced by the Danish Companies Act (hereafter DCA) 7. The DCA consolidates and replaces both the DPCA and DPLCA. The DCA relaxes some of the above-mentioned limitations in the DPCA and DPLCA. Unfortunately the DCA enters in to force in phases, and the part of the DCA enabling the new acquisition structures has as of 1 August 2010 not entered in to force. It is expected that it will enter in to force during the fourth quarter of This prohibition on self-financing exists in similar forms in all the Scandinavian countries 8. The aim of the prohibition is two-fold. First, by making sure that financing the acquisition of its own shares cannot happen with the assets of the Target creditors are (or are meant to be) protected from an acquisition effectively leaving behind no values in the Target for the unsecured creditors. Second, the same protection is afforded to minority shareholders, who would otherwise risk being the owner of a minority interest in an acquired company, where all assets had directly or indirectly been transferred or pledged in favor of the interests of the majority shareholder in whose interest the acquisition had been made. 5 This is partly a result of the implementation of the EC directive no. 187 of 14 February The rights of employees (which can be anything from termination periods longer than the statutory termination periods to the use of cell phones for private calls or the availability of company summerhouses) in Denmark are to a very large extent regulated by collective agreements between employer organizations and unions. Special care needs to be taken with respect to the relationship between the relevant union(s) and the Target and often representatives of the union(s) will have to be informed about the possible acquisition before the employees (and perhaps also before the share purchase agreement has been signed). 6 The DPCA governs public limited companies and the DPLCA private limited companies. 7 The DCA governs both public limited companies and private limited companies. 8 See footnote no. 2.

3 Aquisition 3 The Danish prohibition on self-financing thus requires any acquisition to be fully financed by the acquiror up-front. However, as we will see below the requirement to fully finance an acquisition up-front does not have to be overly cumbersome, and can to some extent be alleviated by choosing the right acquisition structure. 2.2 The Danish Companies Act The Danish Companies Act replaces the Danish Public Companies Act (Consolidated Act no. 649 of 15 June 2006) and the Danish Private Companies Act (Consolidated Act no. 650 of 15 June 2006). The main part of the DCA entered in to force on 1 March 2010 under Executive Order No. 172 of 22 February However, some parts of the DCA will only enter in to force in phases and no Executive Orders have been issued yet relating to those remaining parts of the DCA that have not yet entered in to force. The DCA brings about a number of changes, of which the main are: a) the reduction of minimum share capital to DKK 80,000, b) the possibility to postpone the payment of the subscribed share capital (up to 75 % of the share capital provided that at least DKK 80,000 has been paid up), c) the simplification of paying for shares in assets and paying dividends in assets, d) the company may in certain circumstances finance the acquisition by a third party of its shares, e) further possibilities for the company to grant shareholder loans and loans to parents, f) the introduction of a supervisory board in addition to or as an alternative to a board of directors, g) no limit for acquisition of own shares provided such acquisition is financed within the company s distributable equity. This article will review the changes arising under the point d and g. Unfortunately, as previously mentioned, both section 206 of the DCA which relate to the possibility of selffinancing and section 197 of the DCA which relate to buy back of own shares have as of 1 September 2010 not yet entered into force. 2.3 Self-financing The self-financing prohibition under the existing DPCA Acquisitions of Danish companies have been structured as a result of both tax consideration but more often in consideration of the prohibition on self-financing. This prohibition stems from section 115(1) and (2) of the DPCA, which reads: 115. (1) A company shall not grant loans to or provide security for shareholders in public or private companies, the members of the board of directors or the management board of the company or its parent company. [ ] (2) A company shall not grant loans to finance the acquisition of shares in the company or shares in its parent company. Nor shall a company make assets available or provide assets as security in connection with such acquisition.[ ] 9 9

4 4 David Sander Hjortsø The prohibition imposes two restrictions on the Target: it may not (a) grant a loan to finance the acquisition of its shares or the shares of any of its parent companies 10 or (b) make assets available (including by way of pledging or otherwise providing a security over such assets) to a third-party in connection with the acquisition of its shares. The prohibition must be understood very literally in that it only applies to the Target and its subsidiaries. This means that structures that use other means than granting security over the assets of Target or providing loans can freely be used to up-stream funds. A typical example is that the acquiring company (hereafter Bidco) may pledge its assets including the shares of Target as security for the acquisition funding without this being contrary to the prohibition. However the structures typically used today are essentially after-financing (though timing wise, they may take place within a very short time frame and still comply with the limitations of the DPCA) whereas the changes in the DCA will allow for financing of the acquisition prior to or at such time as it is made. The prohibition on self-financing has no time bar provision. Financial assistance covered by section 115 of the DPCA by Target to Bidco two years after the completion of the acquisition in order for Bidco to pay interest on the loan used to pay for the shares of Target is prohibited. Guarantees granted under loan arrangements where Target guarantees for Bidcos obligations must also be limited not to include obligations that arise from acquisition debt. The prohibition on making assets available includes an agreement 11 with the Target whereby the Target undertakes to make a specific dividend payment on or after completion of the acquisition. However, the prohibition does not cover plans to make a dividend payment to the extent it is not legally binding on Target before the acquisition is completed. The inclusion of parent company in section 115(1) means that Targets subsidiaries are also covered by the prohibition. The Danish Companies and Commerce Agency has construed this as including subsidiaries located in different jurisdictions irrespective of these subsidiaries not being subject to Danish law, because they are directed by the Target, whose Board of Directors 12 therefore have a duty to ensure that the subsidiaries do not undertake obligations that are not in accordance with Danish law The self-financing prohibition under the new DCA The DCA still contains a prohibition similar to the one in section 115(2) of the DPCA, however unlike the DPCA it contains an exception to the prohibition in subsection (2). Section 206 of the DCA reads: 10 parent company is defined in section 2(2) of the DPCA and section 6 of the DCA as any company that either owns the majority of a company or directly or indirectly can exercise a dominant influence of the company 11 The use of agreement is important, in that the plan to pay a certain dividend is in accordance with section 115(2) of the Danish Public Companies Act, but a legal commitment to pay that dividend is not, thus the tipping point is whether or not there is an agreement (written or otherwise) prior to the acquisition. See also footnote no Under the new DCA a public limited company may have different types management structure, and where it has previously always been the Board of Directors that have had this authority the Management Board may instead be the relevant management organ if the Public Limited Company has a Supervisory Board rather than a Board of Directors. Similarly for limited liability companies, where the relevant management organ may be the Board of Directors or the Management Board if there is no Board of Directors or Supervisory Board. Danish companies are almost always organized with a Board of Directors consisting of minimum 3 Directors, and the term Board of Directors will thus be used for the remained of the article.

5 Aquisition 5 206(1) A limited liability company may not, directly nor indirectly, advance funds, make loans or provide security for a third party's acquisition of the limited liability company's shares or shares in its parent company (but see subsection (2) and sections 213 and 214). (2) However, if the requirements in subsection (3) and sections 207 to 209 on approval by the general meeting, reasonableness of the resolution, report by the central governing body and arm's length terms are satisfied, a limited liability company may, directly or indirectly, advance funds, make loans or provide security with a view to a third party's acquisition of the company's shares or shares in its parent company. (3) The limited liability company's central governing body must ensure that any third party receiving financial assistance is credit rated (see subsection (2)). 13 Provided certain conditions are met, it is possible under section 206 to provide loans or grant security over assets to Bidco. The conditions required to be met are: a) the party receiving the financial assistance must be credit rated, b) the general meeting must approve the financial assistance and the financial assistance must be recommended and described in a written report by the Board of Directors, c) the size of the financial assistance is reasonable taking the financial position of the company (or if the company is the parent company the company s group) into consideration, d) the financial assistance is provided within the company s distributable equity, and e) the financial assistance is provided on arm s length terms. As mentioned above section 206 has not yet entered in to force, and thus no financial assistance has yet been provided to an acquiring company. This means that there is currently no practice relating to the 5 conditions and what is required to fulfill them. However, the evaluations of the above-mentioned conditions are the duty and responsibility of the relevant management organ, and in this context it is expected that some of these conditions will require external adviser s opinions. It is expected that auditors will be able to provide the credit rating of Bidco, however this may mean that a credit rating for Bidco where Bidco is an SPV may become problematic. The written report from the relevant management organ must contain the following: the background for the managements proposal for the acquisition financing, the Targets interest and benefit in the acquisition (and financing hereof), the terms and conditions of the financing, a description of the consequences of the financing on the Targets solvency and liquidity, and the price that Bidco will pay for the shares. The general meeting must approve the financial assistance by at least 2/3 majority. The arm s lengths terms-test must ensure that the financial assistance is only granted where a commercial lender would be willing to grant a similar type of financial assistance 13 ompanies%20act%20%20-% pdf

6 6 David Sander Hjortsø on the same terms. This would include the interest, maturity and margin, but it is unclear if this also includes the security that a commercial lender would typically require. Financial assistance provided under section 206 of the DCA requires considerable work being undertaken by management and as it is also management who is liable for deficiencies in the recommendation and report relating to the financial assistance that management is willing to at least risk that it incur liability 14. Further, financial assistance provided under section 206 of the DCA is still limited to the distributable equity of the Target, and is thus no larger than the after-financing otherwise available under the old rules. 2.4 Considerations relating to self-financing For any in-house counsel whose company wants to acquire a Danish company it is important to be mindful of the requirements on the process and on the management of the acquiring companies. If the management of an acquiring company or a company being acquired provides a loan or grants security in a manner not in accordance with Danish law both the management personally and the company will incur or risk incurring liabilities. The management of the Target is responsible both under the DPCA and the DCA for any mismanagement of the Target including wrongful financial assistance and illegal shareholder loans. 15 Under section 115(2) of the DPCA, where any financial assistance is prohibited, management could be held personally liable for any loss incurred by the Target (and thus Targets shareholders or its creditors) if they granted such illegal financial assistance. Section 206 of the DCA allows for financial assistance if providing it is reasonable for the Target. It is therefore management s duty to take a view on the reasonableness of the financial assistance. The standard for when liability is incurred by the management is the so-called culpa rule. The culpa rule is a rule based on the Roman law culpa and developed through Danish case law, so that generally the management is subject to liability with respect to wrongful acts or omission provided these are caused intentionally or negligently by the management. However, when testing if an act or omission was negligent Danish courts will take the business judgment rule in to account. Management will therefore have quite a bit of leeway in determining if providing the financial assistance is in the interest of the Target, and both direct, strategic and commercial benefits arising from the acquisition facilitated through the financial assistance should be taken into account. Financial assistance provided contrary to section 206 of the DCA or section 115 of the DPCA fall due for immediate repayment upon being judged illegal (which may give severe liquidity problems for Bidco). In addition to the repayment a punitive interest will be applied 16. Any security must be released, however security granted to a third-party who did not know that the security was illegal financial assistance may still be enforceable if such security is not released before it is enforced against. 14 In all likelihood this can be alleviated by either a limitation wording in the loan agreement or by way of a specific Directors and Officers insurance covering this type of claim from shareholders. 15 Section 140 of the DPCA and Section 361 of the DCA 16 The interest defined in Interest on Overdue Payments Act (Consolidated Act no. 743 of 4 September 2002) plus a 2 % p.a. margin

7 2.5 Identification of acquisition debt Aquisition 7 The prohibition on financial assistance is not subject to any time bar provisions, and thus up-streaming funds by other means than dividend payments are subject to the abovementioned limitations. The consequence is that it becomes important for Bidco to be able to identify payments that relate to the acquisition debt i.e. mandatory or voluntary repayments of the debt or interest payments and other payments such as operational credits or payment of corporate taxes. This is very important where a debt-pushdown takes place, as it is important that the new debt being taken on by the Target is not acquisition debt, but is operational debt taken on for the purpose of freeing additional liquidity in Target. This liquidity may ultimately be used for dividend payments, which is not a prohibited form of up-streaming of funds. A typical way to do this is to segregate the acquisition debt from any other debt, either through tranching or by way of having different facilities for different purposes. This will allow a precise flow of funds to be reconstructed, if for example it needs to be ascertained if a guarantee, that has appropriate limitation language, extends to a particular facility or tranche of a facility. 3 Acquisition structures 3.1 The existing models: Two common models are often used in acquisitions, where the acquisition requires debt financing or where the acquiror will want to release as much liquidity from the target as possible immediately after the completion of the acquisition. Ultimately these twomodels have been fused in to one model, which has been used extensively in recent leveraged buy-outs in Denmark The share pledge model Bidco 1. Acquisition financing 4. Share Pledge Agreement Bank 2. Purchase Price 3. Shares 5. Registration of share pledge in shareholders registry Seller Target The first model requires that a loan agreement, a share pledge agreement and registration of share pledge (typically a copy of the shareholders registry kept by the Target and in some cases a registration on the Company s register at the Personal Register (Dk: Personbogen)) are completed on the same day as the share purchase agreement between Bidco and Seller closes. This may not be possible in some cases and Bidco may

8 8 David Sander Hjortsø alternatively obtain bridge financing for the period from the closing of the share purchase agreement and such time as the share pledge is effective. This model does not provide for any financing in and of itself, but allows Bidco to obtain less costly financing, as the financing will be secured by the shares of the Target along with the financial covenants and undertakings imposed by the Bank on Bidco (and thus indirectly on Target) The dividend model Bidco 1. Acquisition financing 7. Payment of proceeds from dividends Bank 2. Purchase Price 3. Shares 6. Payment of dividend 4. Incur operational debt to free liquidity and use all distributable equity 5. Security over assets for operational debt Seller Target The second model requires the Target to have sufficient distributable equity to pay out dividends, 17 and that such dividend payment does not exceed what would be a reasonable dividend payment taking into consideration the financial position of the Target. The financial position and capital reserves of the Target must thus remain warrantable for the operation of the Target after the dividend payment. 18 Under Danish law, any dividend payments must be recommended by the Board of Directors, and then resolved by the general meeting. The general meeting may resolve that the Board of Directors be allowed to pay out dividends during a financial year (extraordinary dividends) without resolving on the specifics of the dividends 19. It is the Board of Directors which must make the decision on the size of the dividend payment, and it will also be that Board of Directors that will ultimately be held responsible if the dividend payment exceeded an amount that was reasonable for the Target at the time of the payment of the dividend. The second model is as mentioned above only in accordance with the DPCA and DCA if there is no legal arrangement in place prior to the completion of the acquisition of Target whereby Target is required to pay a certain dividend DPCA section 115(5) and DCA section The capital reserves include the equity capital, debt capital and warrantable loans. 19 DCA section 182(2) 20 See decision of the DCCA in the JAMO case and subsequently confirmed by the Danish Supreme Court in the Procuritas case (U H)

9 Aquisition The LBO model 4. Share Pledge Agreement Bidco 1. Acquisition financing 9. Payment of proceeds from dividends Bank 5. Registration of share pledge in shareholders registry 2. Purchase Price 3. Shares 8. Payment of dividend 6. Incur operational debt to free liquidity and use all distributable equity 7. Security over assets for operational debt Seller Target The typical model used for acquisitions in Denmark is a hybrid of both models. This model consists of two steps. The first step is the acquisition of the shares of Target by Bidco financed through a bridge facility equivalent to the purchase price of the shares of Target minus the equity contributed in Bidco. If Bidco is a special purpose vehicle this will typically be all the contributed equity (to the extent legally possible) otherwise it will be whatever free reserves Bidco will choose to use. This bridge facility may be secured by a pledge by Bidco of the shares of Target. The second step will be the repayment of the bridge facility through cash paid out as dividend from Target, such payment to be funded by Target taking over new debt (typically by acceding to a senior facility with Bidco as original borrower, and then making a draw-down on that facility after accession) in order to fully use its distributable equity. This draw-down will be secured by a pledge of the assets in Target and any material subsidiaries of Target in favor of the banks providing the new debt to Target. If there is still any acquisition debt remaining at Bidco, because the payment of dividend from Target was less than the acquisition debt, Bidco will have to service this debt only through the resources that can be paid out as dividends from Target, and any crossguarantees provided under the new debt cannot extend to Target guaranteeing the acquisition debt. This involves several steps, and is from a legal point of view more complicated as it requires a larger set of documents to be negotiated and often has a tighter time schedule, however it is a model that has been used extensively and one that the banks providing financing are comfortable with. 3.2 New acquisition models Once section 197 and 206 of the DCA enters in to force new models will be available to acquirors. These models allow for a larger degree of up-front financing than previous

10 10 David Sander Hjortsø models, however the extent of the up-front financing (the size of the distributable equity) is not changed The financial assistance model Bidco 1. Financing of Purchase Price not financed by Bidco equity or Targets distributable equity Price 5. Share Pledge Agreement Bank 6. Registration of share pledge in shareholders registry 4b. Purchase Price 4c. Shares 4a. Loan from Target to Bidco of amount equivalent tp the distributable equity of Target 2. Incur operational debt to free liquidity and use all distributable equity 3. Security over assets for operational debt Seller Target Target must prior to step no. 2 have fulfilled the criteria required for section 206 financial assistance Section 206 of the DCA allows for a new model, where the Target finances a part of the purchase price by lending an amount equivalent to its distributable equity to Bidco at the same time as the completion of the acquisition thus avoiding the cumbersome two-step procedure reviewed above. Involving Target to the extent required under 206 moves a considerable part of the procedural burden and cost from Bidco to Target, as it is Targets management who must now negotiate part of the financing and prepare the documentation required under Section 206. As in-house counsel one must understand that this requires more resources and willingness from Target than having the package dictated solely by Bidco. In addition to the benefits of some degree of up-front financing, it will also be possible to use the financial assistance under section 206 of the DCA after the completion of the acquisition in order to finance Bidcos acquisition debt as Targets distributable equity becomes available.

11 Aquisition Own financing share purchase model Bidco 1. Financing of Purchase Price not financed by Bidco equity 5. Share Pledge Agreement Bank 6. Registration of share pledge in shareholders registry 4b. Purchase Price for remaining Target shares 4c. Remaining Target Shares 2. Incur operational debt to free liquidity and use all distributable equity 3. Security over assets for operational debt Seller 4a. Buy-back of own shares equivalent to size of distributable equity Target Target must prior to no. 4a have received approval from GM to buy-back own shares The DCA removes the limit on buying own shares, which was previously capped at 10% of the share capital. This allows for a different and simpler model than the one detailed above: The Target may purchase an amount of own shares under section 198 and 199 equal to the amount that it could have provided Bidco as financial assistance under section 206 of the DCA. A similar structure has been used prior to the DCA by way of a reduction of share capital. This is not a model that has been used broadly as it provides a number of disadvantages for Target, both from tax and accounting perspectives, but also because its share capital can only be restored by injecting capital. Buying own shares under the new model however has the benefit of allowing a quick recapitalization of Target by selling the shares to Bidco if needed, or alternatively the use of own shares as security for the operational debt. Please note that it may however present some accounting or tax problems to use this method, whereas the financial assistance model may not have these disadvantages. Using the share buy-back model reduces the complexity of the work imposed on management of the Target. The resolution that the Board of Directors will give to the general meeting can be less detailed than required under section 206 of the DCA, and does not require a credit rating of a third party. This should at least theoretically allow Target to make the required determinations without using external advisers. Yet it still requires Target to take on sufficient debt to have free reserves it can distribute and it also requires the necessary steps be taken to ensure that the resolution allowing for the share buy-back is approved by the general meeting.

12 12 David Sander Hjortsø 4 Conclusion The DCA introduces new possibilities for an acquiror, however these new possibilities come at a cost for Target. Using these possibilities require a Target that is intent on using resources internally and coordinate tightly with the acquiror in structuring the purchase. This means that Targets willing to undertake this work, will require severe break-clauses early in the transaction, so that the Target will be compensated should the acquiror choose not to complete the acquisition. For the acquiror the possibilities allow for slightly more flexible financing both at completion of the acquisition and after the acquisition. Section 206 of the DCA allows Target to provide financial assistance at times where Bidco may require funding from Target in order to repay acquisition debt or interest hereon, which was previously only possible by way of payment of dividends. It remains to be seen if the new structures and possibilities given under the DCA will give the acquiror a sufficient benefit to warrant the extra resources required to fulfill the various criteria, considering that the amount of financial assistance is in any case limited to the size of the distributable equity of Target. Other considerations than legal considerations i.e. tax considerations could lead to financial assistance in the form of a loan being more beneficial a form of financing than dividend payments, in which case the new structures will prove useful. David Sander Hjortsø currently works as a Senior Legal Adviser in Danske Markets. Danske Markets is the investment banking brand of the Danske Bank Group, which is the largest Danish bank and one of the largest Scandinavian banks. David works primarily with corporate and institutional banking and acquisition and leveraged finance at Danske Bank. For more information regarding Danske Markets please see or